An introduction to Engaging ESG - Ep1

Transcript

Kyla: Welcome to our ‘Engaging ESG’ podcast series. This series is going to provide insights on a range of ESG-related topics ranging from climate change to accounting and reporting matters. I am your host Kyla Visser, a manager in Accounting Consulting Services in the PwC South African practice. 

For this first podcast in our new series, I am pleased to welcome Renitha Dwarika, Reporting Leader for PwC Africa and a technical accounting partner in our  South African practice.

Welcome to the podcast Renitha.

Renitha: Thanks Kyla, I am really excited about this podcast series and looking forward to engaging on ESG matters today!

Kyla: Renitha, you are no stranger to the podcast studio, having been a guest on the Telco Talks podcast series, and just recently a guest on the retail podcast series "On the Top Shelf’’. But today, we are putting you in the spotlight once again to talk about a very ‘hot’ topic being sustainability and ESG. There have been many discussions on the topic by various stakeholders, including investors, governments, audit firms and most recently standard setting boards. There are so many nuances to this topic, but to start off, could you share with us the importance of sustainability reporting and why companies need to start thinking about this?

Renitha: Kyla, there is a lot to think about when it comes to ESG. The simple answer is that companies should not only be thinking about ESG but rather embedding ESG into every aspect of their business, particularly their strategy and performance management. Succeeding in business is no longer only about profitability and companies don’t operate in a silo, therefore a company’s broader societal impacts are increasingly important to investors and other stakeholders. In the last few years stakeholders looked to factors, other than profit, to evaluate the value proposition of a company. 

Kyla: And what might these other factors be Renitha? Would you share some examples?

Renitha: Well, there are a wide range of issues that fall under the “E” in ESG for example:  a company's impact on the environment through its greenhouse gas emissions, water usage and waste management. The “S” or Social aspects would be for example: how a company treats its employees and addresses diversity and inclusion in the workplace and lastly the “G” : focusing on how companies are governed, how they establish remuneration policies, responsible investment practices and ethics to name a few. 

Kyla: If I think about a company’s financial reporting under International Financial Reporting Standards (“IFRS”), there is a focus on the profits and related disclosures whereas now with ESG, there are many other non-financial factors that companies need to consider that directly impact on the value of the company. It appears that stakeholders are increasingly requiring ESG related information, companies to evidence a convincing ESG strategy and then to report on  ESG performance.  

Renitha: That’s right. From an ESG perspective, there is increased focus on a company’s enterprise value, which goes beyond the monetary value created for a range of stakeholders  and expands to positive or negative impact the company has on its stakeholder and the six capitals. Investors and other stakeholders are now demanding more information on the ESG factors that tells the story of a company’s broader societal impact which is not necessarily addressed under the IFRS requirements. With many different non-financial reporting frameworks already being applied by companies, the ESG reporting landscape is referred to as an ‘alphabet soup’ of choice. And this is creating an urgent need for standardised sustainability reporting which aids comparability and consistency. 

To answer your question on the importance of sustainability reporting, the value of sustainability reporting is that it enables organisations to be transparent in reporting on their impacts and risks in line with what investors and other stakeholders are asking for. 

Kyla: Ok, great. I am going to shift the focus to talk a bit more about what is happening in our local market. A number of companies have made net zero commitment announcements and just recently ahead of COP26, South Africa joined a partnership with other countries to support a just transition to a low carbon economy and a climate resilient society. We are also seeing our local financial institutions issuing green bonds and our listeners can look forward to our banking industry podcast episode where we will discuss these green financial instruments. Let’s perhaps start with net zero. PwC has published a 2021 Net Zero Index publication which outlines South Africa’s progress in this space. Would you share some highlights of the findings with us?

Renitha: Yes, sure. Whilst it is a positive sign that many South African national and multinational companies have made net zero commitments, some by 2030 and others by 2050, South Africa has seen consecutive increases in carbon intensity with limited GDP growth to show for the implied growth. In order to meet the goal to limit the global temperature increase to 2°C, South Africa will therefore need to cut its emissions by 60–75% by 2050. South Africa remains the worst performer in the G20 in terms of carbon intensity.

However, whilst South Africa and regulators are focusing on the climate aspect of ESG, companies and boards are focusing on social aspects as well, such as impact on employees, communities and rising levels of unemployment.  The announcement to support a just-transition to a low carbon economy is positive. The use of the term ‘just transition’ in the South African context is particularly important given the high levels of  poverty, inequality, and unemployment. It is also often framed as a transition to a lower-carbon economy without excessive losses in jobs. Workers that could be displaced by transitioning from a carbon intensive economy should, for example, be upskilled to integrate effectively into the labour market of the low-carbon era.  I highly recommend our PwC publication on what a just transition means for jobs in South Africa for our listeners. 

Kyla: Fantastic Renitha. Our listeners can find this publication on www.pwc.co.za in the publications and insights section. 

On the topic of stakeholder views, the high level results of the 2021 PwC Global Investor ESG Survey has recently been released. This survey captures the views of 325 investors around the world, majority of whom are asset managers and analysts with investment firms and banks. Renitha, could you share with us the stats reported in this survey.

Renitha: Sure Kyla - you really are up to date with the ESG publications! Climate is the leading ESG consideration for investors surveyed, and reducing Scope 1 and 2 greenhouse gas (GHG) emissions was cited by 65% of respondents as the ESG issue companies should prioritise. 

What’s more, 82% of investors said it is important that ESG reporting explains the rationale for environmental commitments, along with detailed plans on how it plans to achieve them. Ensuring worker health and safety, improving workforce and executive diversity and inclusion are other priority ESG considerations identified.

Kyla: Interesting! What other points has the survey brought to light?

Renitha: Strategy was another key consideration. According to the investors surveyed, ESG strategy starts at the top. 82% of investors said ESG needs to be embedded in the corporate strategy, and by a wide margin 66% of respondents said they are most confident that ESG issues are being addressed if someone in the C-suite is accountable. More than half of those respondents (53%) think it should be the CEO.

In my view, the survey certainly highlights the need for a single set of globally aligned sustainability reporting standards to improve consistency and comparability.  In the absence of this, ESG investors and other stakeholders are extremely challenged in evaluating ESG matters. Companies need to focus on incorporating ESG standards, taking into account international frameworks and other benchmarks for performance while ensuring consistency and transparency of the treatment of ESG matters within the financial statements. There are currently a number of frameworks which are already being applied by companies. Stats cited by the Chartered Governance Institute of South Africa 2021 publication reflect that 58% of JSE Top 40 companies refer to the Task Force of Climate-Related Disclosures in their integrated reports and 63% of the JSE Top 40 companies take ESG into account in their core strategy. Companies need to ensure that ESG disclosures are consistent and transparent. When you tell investors and other stakeholders how you plan to reset your strategy, reimagine your reporting, reinvent your operations, and drive toward new outcomes, you build trust while creating sustainable value for the long term.

Kyla: Thanks so much for that Renitha! Earlier you mentioned consistency and comparability in reporting, and there are a plethora  of different initiatives and non-financial reporting standards already in this regard - TCFD, GRI, SASB, Climate Disclosures Standards Board and a whole lot more. I can now understand why these are referred to as the ‘alphabet soup’ - there’s just so many acronyms! Could you provide some context on the key non-financial reporting standards?

Renitha: That is another great question Kyla. Let me touch on a few of the major ones you have mentioned. GRI, which is the Global Reporting Initiative. GRI is an independent international organisation, with global standards for sustainability reporting as its main product. They're voluntary for all entities and have a multi-stakeholder focus. GRI covers general, universal topics as well as specific areas relating to Environmental, Social and Governance topics. 

Secondly, there is the TCFD, the Task Force for Climate-Related Financial Disclosures, which is the sustainability reporting framework focusing solely on climate change. At the heart of it, TCFD is helping an entity assess the risks of climate change and consider the financial implications it has on an entity. The TCFD recommendations are for entities to voluntarily disclose climate-related information, to provide investors with more information on the financial impact of climate risk. A key TCFD recommendation is the use of scenario analysis, which allows a company to understand and quantify the risks and uncertainties it may face in different scenarios.

The Sustainability Accounting Standards Board, known as the SASB has developed non-financial reporting standards to provide investors with comparable non-financial information. The standards aim to provide a minimum bar for disclosures, standardised by industry, so that investors can compare between entities. Unlike the GRI, the SASB standards cater more for the needs of investors and other providers of financial capital. The SASB has now merged  with the Integrated Reporting Foundation to form the Value Reporting Foundation.

But there have been developments in this space...

Kyla: … you are right Renitha, the developments tie into the demand by investors for improvements in consistency and comparability in non-financial reporting. 

Renitha: Yes Kyla, you are spot on there!  And this demand is partly arising from the investor concerns that entities are essentially ‘greenwashing’ information. Greenwashing is a term used for entities being selective in disclosing information which provides a positive picture of the sustainability of the companies products and practices, which leads to misleading reporting. An aligned set of global sustainability standards will help mitigate that risk of greenwashing and achieve consistency and comparability in reporting.

Kyla: The IFRS Foundation has made an exciting announcement recently at the COP 26 conference. Please tell us more about this.

Renitha: Yes Kyla. A major step has been taken towards globally aligned ESG reporting. At the COP26 conference, the IFRS Foundation announced the creation of the International Sustainability Standards Board or the ISSB. This was in response to the call for globalisation of sustainability standards. The Climate Disclosure Standards Board and Value Reporting Foundation mentioned earlier merged to form the ISSB. Two prototype standards have also been published, and the ISSB’s goal is to publish the first climate standard in the second half of 2022. 

Kyla: Wow - this is indeed very exciting and seems to be moving forward at a rapid pace. What do the prototype standards cover?

Renitha: The first prototype provides guidance on the disclosure of material information and a hierarchy of the guidance to be used if an ISSB standard is not yet in place for a material ESG topic. It is based on the four pillars used in the recommendations by the TCFD which are Governance, Strategy, Risk Management, and Metrics and Targets. The second provides guidance on climate reporting, which will establish narrative-based disclosures linked to the same four pillars referred to above, and cross-industry metrics, including metrics on greenhouse gas emissions.

Kyla: Now that the ISSB has been established and there is a set of globally aligned non-financial reporting standards in the pipeline, how should one think about the relationship between the financial reporting and non-financial reporting in the future? Is there a risk that financial reporting may be overlooked given the emphasis investors and other stakeholders are placing on non-financial reporting?

Renitha: I don’t believe that this will be the case at all. The ISSB will sit alongside the IASB (International Accounting Standards Board), under oversight by the IFRS Foundation. In addition,investors rely on financial information for their analysis and key decision-making. Over and above the financial information, investors are looking for non-financial information to understand what impacts enterprise value. So certainly both are important and there is an interaction or trade-off between the two and there should be consistency in the information reported in the financial reporting section and the front half of the annual report which covers the non-financial reporting and this is an area which is receiving a lot of investor focus and scrutiny.

Kyla: A key takeaway from this discussion for me is that consistency sounds like a key word in the reporting world! It is also clear that the ESG world is changing at quite a pace and we can expect developments in the future.  And on that note, we have come to the end of this episode and have indeed closed off with exciting developments. Renitha, do you have any parting thoughts or reflections that you would like to share with our listeners?

Renitha: Yes. I do have a few closing points from my side. From a reporting perspective, in our local African market, non-financial reporting frameworks have not yet been mandated or regulated. However, that should not deter companies from planning and mapping out their ESG risks and opportunities and incorporating their responses into their core strategy.  The reality is that it is not about the report, it is about how you embed and respond to the changing business landscape where ESG factors are crucial to long term business success. There is significant investor activism in this regard and we have seen investor activist bodies such as JustShare and large investment houses such as BlackRock, which is the largest asset manager, raise questions and challenge many entities' ESG disclosure. Blackrock has stated that they will use proxy votes to make sure that companies report properly on climate risk. The long and medium term resilience of business models and the ability to create value will depend on integrating ESG into core strategy. ESG performance will determine whether entities get access to financing and even have access to insurance at reasonable rates. Ultimately, entities will need to report and deliver on their ESG claims on the basis of robust and trustworthy data. Lastly, all I can say to our listeners is watch this space for more exciting developments on ESG reporting and accounting developments.

Kyla: Thank you for joining us Renitha and sharing these interesting ESG insights! To our listeners, stay tuned for our next episode in the Engaging ESG series where we will explore the ESG impacts in the banking industry. 

Kyla: “This podcast is brought to you by PwC. All rights reserved. PwC refers to the South African member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This podcast is for general information purposes only, and should not be used as a substitute for consultation with professional advisors”